The great billion dollar drug scam

Drug corporations such as Novartis and GlaxoSmithKline have stated that companies producing generic drugs - often Indian - are able to bypass costs, and sell their 'copied' drugs for a fraction of the price of the patented product [EPA]

Alongside pneumococcal diseases such as meningitis and pneumonia, rotavirus-related diarrhoea is a primary childhood killer in developing countries, thought to snuff out the lives of 500,000 children each and every year. An overwhelming 85 per cent of these children are African and Asian. The need for medical miracles is as great as ever, but corporate mispricing generates huge profits, while driving up the price of life saving medicines.

British-based drug corporation GlaxoSmithKline (GSK) recently offered a five-year deal to supply poor nations with 125 million doses of the rotavirus vaccine - Rotarix - at $2.50 a dose, just five per cent of the current going price in Western markets. Through the GAVI group, the international vaccine agency financed by developed nations such as the UK, it is hoped that GSK and pharmaceutical multinational Merck - who, between them, dominate the rotavirus vaccine market - will provide a secure line of low-cost drugs for as many as forty countries in the near future.

But is it really a discount, and if so, who is paying the cost?

The financing mechanism subsidising the vaccine is named the Advance Market Commitment (AMC), a pot created by the G8, as well as the World Bank and the Gates Foundation, as a "pull" incentive for drug multinationals to consider developing countries' long-term markets for pharmaceutical "public goods", such as vaccines. Rotarix has taken off well: Since 2007, some 50 million children - through 100 million doses - have already benefited from Rotarix; by 2009, global Rotarix sales reached $440 million - increasing by 50 per cent from 2008, and Merck's Rotateq reach $564 million in sales.

GSK Chief executive Andrew Witty described the pricing structure as, "neither a gimmick nor a one-off philanthropic gesture", but rather "part of a concerted strategy to change our business model" - designed to combine "commercial success with long-term sustainable contributions".

Pricing structures and profits

Drug companies such as GSK have often claimed that the high cost of "innovation" ie: research and development (R&D) is between $1bn and $1.7bn to bring a new drug to market. The AMC and GAVI - collecting some $4.3bn to finance purchase of vaccinations, were designed with the premise that the high cost of drug multinationals' R&D must be met.

During the past several decades, the pharmaceutical industry in the US - more than half of which comprises European-based companies - has largely been the most profitable industry in the nation's economy, thanks to mechanisms such as the lack of a government-imposed pricing structure. "Free pricing and fast approval secure rapid access to innovation without rationing," said Daniel Vasella, the former head of (Swiss-based) Novartis, of the advantages of doing business in the US.

Drug multinationals claim that US consumers are forced to fund the necessary research and development in order to keep global innovation going. In Australia, Europe, as well as Canada - the source of much prescription drug "re-importing" by US citizens, where drugs sometimes sell for half the going US price - governments ensure pricing structures render patented drugs affordable.

While drug multinationals generate considerable profits from these countries, about 50 per cent of global drug industry profits are generated in the US. In 2006, for instance, global prescription drug sales totalled more than $640bn - of which almost $300bn were US-generated sales.

But the real deception is less the Machiavellian tactics used by Big Pharma to Botox the bottom line than the terrible myth behind the "true" price of innovation: the $1bn pill. From 1996-2005, Big Pharma firms spent $739bn on marketing and administration (M&A): "Administration" costs here include accounting, executive salaries (including bonuses, stock options etc) - as well as human resources expenditure. "Marketing", meanwhile, consists of direct-to-consumer advertising, sales pitches and free samples to doctors, alongside advertising in medical journals.

From the outset, it is possible to see that R&D ranks second to last in terms of expenses. But the breakdown of R&D itself is opaque: companies do not list actual expenses for the development of a particular drug, claiming that information comprises proprietary and/or confidential commercial secrets.

Yet, according to the Harvard Business Review: "The cost per new approved drug has increased more than 800 per cent since 1987, or 11 per cent per year for almost two decades." Drug corporations such as Novartis and GSK state that companies producing generic drugs - often Indian - are able to bypass such costs, and sell their "copied" drugs for a fraction of the price of the patented product - often undercutting the intercontinental firms by as much as 65-99 per cent.

The "$1bn cost" is derived from a 2003 study [PDF] published in the Journal of Health Economics by Joe DiMasi et al from the Tufts Center for the Study of Drug Development. The authors and their organisation claimed that the study was unbiased, despite the fact that the Tufts Center is itself some 65 per cent financed by drug companies.

Though the findings have been normalised as factual by the media, the facts have long since been debunked by independent specialists.

The authors surveyed ten large pharmaceutical corporations (between them responsible for 42 per cent of R&D expenditure in the US, where the bulk of such work is carried out), examining the R&D costs of 68 randomly selected drugs, and determined the cost of the development of each at $802 million (elevated to $1bn when adjusted for inflation).

As the data was submitted confidentially by the drug companies to the authors, there is no way to verify the quality of the information, nor was there any accounting for the potential volume of intra-company corporate mispricing. The names of the firms were not mentioned; nor were the names of the drugs, the type of drugs; or the status - whether a priority drug, comprising advanced treatment, or a "me too" drug - ie: a variation of products already on the market.

'Demythologising' the costs

For starters, the $802 million figure failed to take into account the opaque and strange manner of accounting involved, beginning with "capitalised costs". According to the authors, R&D expenditures, "must be capitalised at an appropriate discount rate - the expected return that investors forego during development when they invest in pharmaceutical R&D instead of an equally risky portfolio of financial securities".

As Marcia Angell, US physician, former editor in chief of The New England Journal of Medicine and senior lecturer at Harvard Medical School, stated: "The Tufts consultants simply tacked it on to the industry's out-of-pocket costs. That accounting manoeuvre nearly doubled the $403 million to $802 million."

So, when taking into account updated costs by PhRMA (2006), increasing overall R&D to $1.32bn, more than $650 million has just been included as "research and development" by drug companies claiming mythical profits that might have been generated, had they invested in, say, Wall Street - and not the scientific "innovation" used to justify gross profits from exclusive patents.

The US Office of Technology Assessment (OTA) revealed: "The net cost of every dollar spent on research must be reduced by the amount of tax avoided by that expenditure." The authors used data from official sources such as the Tax Policy Center, to reveal additional tax savings of 39 per cent. Cumulatively, taxpayer subsidies and credits reduced the overall costs from $403 million to $201 million.

Tax secrecy

Moreover, as this Ernst & Young "Tax Planning" article explains, R&D costs are usually shifted to high tax jurisdictions to offset costs. Meanwhile, profits generated by patents are often "re-located" to low-tax jurisdictions. Pharmaceutical companies prefer to generate R&D "expenses" in high-tax jurisdictions such as the US in order to offset the costs against taxable income. Yet the cost of R&D does not included "avoided" tax. Not surprisingly, most pharmaceutical companies are also based in low-tax secrecy jurisdictions such as Delaware in the US, where profits can be shifted into passive profit and intellectual holding companies.

In an article [originally printed in the New Age newspaper, published online here] I wrote with John Christensen, the founder of the Tax Justice Network and a former economic advisor to Jersey, one of the UK's top tax havens, we revealed how tax secrecy and intellectual property (IP) was being exploited to profit drug corporations, rather than serving the needs of vulnerable people.

"Pfizer, Novartis, GlaxoSmithKline - as well as over 60 per cent of Fortune 500 multinationals, all maintain entities in Delaware, taking full advantage of legal and financial opacity tools. In addition to banking secrecy and zero disclosure of beneficial owners, Delaware allows for parent companies to establish holding companies within two days, producing nothing, conducting no economic activity in the state, and generally hosting just one shareholder (the parent company). Such entities, allowing the parent company to pay the newly created entity a "fee" for use of IP, serves as a passive conduit converting taxable income to passive non-taxable profit. The entity's sole purpose is to own and 'manage' laundered income generated from IP."

The gigantic legal expenses incurred by specialists for developing patents, legal defence, sourcing the tax havens and other IP-related issues constitute more costs - included as R&D. This tax optimisation strategy closely resembles that of "high-tech" companies depending on intangible capital for the bulk of their wealth. According to Forbes magazine, by 1999, three of the four richest people in the world made their fortune from intellectual property rights. They owed their fortune, said Michael Perelman, to "Microsoft, one of the major holders of intellectual property rights, befitting the so-called New Economy in which 'DOS Capital' has supplanted Das Kapital".

Profits from AIDS treatment

Intellectual property rights management can be a lucrative business indeed. The first HIV/AIDS treatment, azidothymidine [AZT], sold under the brand name Retrovir, was manufactured by the company Burroughs Wellcome, later incorporated into GSK. In 1983, two years after AIDS was first reported, the US National Institutes of Health and the Pasteur Institute in Paris identified its cause - the HIV retrovirus. In that same year, Samuel Broder, head of the National Cancer Institute (an NIH branch), established a global team to screen antiviral tools, including the AZT molecule discovered by the Michigan Cancer Foundation, subsequently acquired by Burroughs Wellcome.

Broder's NIH-NCI team, alongside scholars at Duke University, discovered the effectiveness of AZT against the AIDS virus and conducted early clinical trials in 1985. As Marcia Angell explained in her illustrative book, The Truth About Drug Companies, Burroughs Wellcome immediately patented the drug and "carried out the later trials that enabled it to receive FDA approval in 1987" after a review of only a few months. The corporation charged patients upwards of $10,000 per year for treatment and heavily congratulated themselves on the achievement of life-saving medicine.

After one such self-congratulatory letter by Burroughs Wellcome's CEO to the New York Times, Broder and his colleagues from the NCI and Duke University responded angrily, stating: "The Company specifically did not develop or provide the first application of the technology for determining whether a drug like AZT can suppress live AIDS virus in human cells, nor did it develop the technology to determine at what concentration such an effect might be achieved in humans. Moreover, it was not first to administer AZT to a human being with AIDS, nor did it perform the first clinical pharmacology studies in patients. It also did not perform the immunological and virological studies necessary to infer that the drug might work, and was therefore worth pursuing in further studies. All of these were accomplished by the staff of the NCI working with the staff of Duke University."

Driving the point home, they added: "Indeed, one of the obstacles to the development of AZT was that Burroughs Wellcome did not work with live AIDS virus, nor wish to receive samples from AIDS patients."

Killer tactics

Paradoxically, the drug Retrovir was classified by the company as an "orphan drug" ie: a drug where there exists a market of fewer than 200,000 people - and therefore not likely to be commercially profitable. This was done to claim 50 per cent credit from the government for the costs of clinical trials. In 2005, GSK was accused of artificially boosting their short-term profit by not increasing production to meet drastically increasing demand - thus creating "scarcity" for their patented product. This was seen as a last bid attempt to milk the patent which was to expire in September 2005. Shortly thereafter, the US government approved generic versions of the drug.

When Ghanaian distributor Healthcare Ltd imported a generic version of the drug (a combination of AZT and 3TC - known as Combivir) from an Indian drug company named CIPLA, providing it at an affordable Indian price (90c per pill), rather than the patented US price ($10 per pill), GSK threatened the distributor with court, prompting Healthcare Ltd to cease sales. Yet even as GSK accused CIPLA of violating patent rights, GSK did not own the "rights" to Combivir in the West Africa regional patent office. AZT and other AIDS treatment remained blockbuster drugs for GlaxoSmithKline, generating $2.4bn profits in the first six months of 1997, thanks in particular, to AZT and 3TC. By 1998, AIDS was being referred to as a "world-wide health crisis", considered by many as, "an epidemic".

GSK subsequently made billions of dollars from a patent, controlled a market, and affected the lives of billions of people worldwide, for something they did not invent. They did claim, however, that they conceived of it working. This notion was enough to exclude the NCI scientists, including Broder, from being listed as inventors.

But is this a one-off example?

Part two of 'The great billion drug scam' will be published later this week.

Khadija Sharife is a journalist and visiting scholar at the Center for Civil Society (CCS) based in South Africa, and a contributor to the Tax Justice Network. She is the Southern Africa correspondent for The Africa Report magazine, assistant editor of the Harvard "World Poverty and Human Rights" journal and author of "Tax Us If You Can Africa".

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera's editorial policy.